What is Accruals?

Accruals are a fundamental concept in accrual accounting (as opposed to cash accounting). An accrual is an expense or income that has been incurred or earned during a period but has not yet been invoiced or received in cash. By recording accruals, you ensure that your profit and loss statement reflects the true cost of running the business in each period, regardless of when the cash changes hands. This is known as the 'matching principle' -- expenses are matched to the period in which the related revenue is earned.

The most common accruals are expense accruals. For example, your electricity bill covers January to March, but you do not receive the bill until April. At your year end on 31 March, you would accrue the estimated electricity cost for the quarter so that it appears in the correct accounting period. Without this accrual, your profit would be overstated for the period ending 31 March and understated for the following period.

Income accruals (also called 'accrued income') work in reverse. If you have completed work for a client in March but will not invoice until April, you record accrued income in March. This ensures the revenue appears in the period the work was performed. On the balance sheet, accrued income appears as a current asset.

Accruals are particularly important at the year end because they directly affect your reported profit and therefore your tax liability. An expense accrual reduces profit (and thus Corporation Tax), while an income accrual increases it. HMRC expects accounts to be prepared on an accruals basis for Corporation Tax purposes (with limited exceptions for very small businesses that may use cash basis accounting). Getting your accruals right ensures you pay the correct amount of tax -- neither too much nor too little.

At the end of each accounting period (typically the year end, but also at month end for management accounts), you review all known expenses that relate to the period but have not yet been invoiced. For each one, you estimate the cost and record a journal entry: debit the expense account (increasing the cost in the P&L) and credit 'accruals' or 'accrued expenses' (a current liability on the balance sheet).

In the following period, when the actual invoice arrives, you reverse the accrual and record the real invoice. This is usually done by posting a reversing journal at the start of the new period, then processing the invoice normally. If the actual amount differs from the estimate, the difference is absorbed in the new period.

For example: you estimate your March electricity at £500. You debit utility expenses £500 and credit accruals £500. In April, the actual bill arrives at £520. The reversal removes the £500 accrual, and the full £520 invoice is recorded. The net effect is £500 in the March period and £20 in the April period.

Common items to accrue at year end include: utility bills, rent if paid in arrears, interest on loans, audit and accountancy fees, staff bonuses declared but not yet paid, and any services received but not yet invoiced.